The following article appeared in the most recent edition of The Hamilton Law Association Journal.
What is the difference between an estate and a trust? And why does it matter for tax purposes?
Definitions in the Income Tax Act
The Act does not distinguish carefully between a testamentary trust and an estate. 104(1) provides that a reference in the Act to a trust or an estate “shall … be read to include a reference to the trustee [or] executor”. A “testamentary trust” is defined in 108(1) to be “a trust that arose on and as a consequence of the death of an individual”. Because the “definition” of “trust” includes “estate”, an estate could qualify as a testamentary trust, which meant that it was entitled to its own set of graduated rates, just like an ordinary testamentary trust.
The graduated rate estate (GRE) concept, however, is intended to ensure that the benefit of, among other things, graduated rates extends only to a GRE. The GRE definition provides that, to qualify as such, an estate must be a testamentary trust (among other things), but the definition also ensures that not all testamentary trusts are GREs.[1]
Distinguishing estates and trusts
A trustee must hold and manage assets for the benefit of the beneficiaries of the trust. The task of a trustee is of indefinite duration subject only to the rule against perpetuities. An executor, on the other hand, must wind-up the estate of a deceased by collecting all assets and discharging all liabilities of the estate. Waters says that the executor’s task “is a task of limited duration, normally not more than between one and three years.”[2]
An executor has many of the same duties as a trustee, but the beneficiaries of an estate do not have beneficial title in the estate’s property while the estate is still under administration. Similarly, the trustees of a trust must act jointly, but the executors of an estate can act severally.
When does an estate cease being an estate, and the property of the estate become settled on a trust or trusts under the will of a deceased individual? The change cannot happen until the total liabilities of the estate are known and specific assets are allocated to beneficiaries or their trusts. The shift might occur sooner for bequests or where an estate has only one beneficiary.
What causes uncertainty? A will might provide for establishing a trust but not express the provision clearly, which will be doubly confusing if the estate executor and the trustee of the testamentary trust are one and the same.
In Ogilvie-Five Roses Sales Ltd v Hawkins (1979), 9 Alta LR (2d) 271, 4 ETR 163 (Alta TD), the Court considered a caveat filed on title to land in respect of a debt owing by the child of a deceased farmer. The farmer had died intestate in 1933, but still the court held that the estate remained under administration until after the caveats had been filed because the administrator of the estate had not taken steps to convey real property owned by the farmer at his death. As a result, the court held that the child-beneficiary had no beneficial interest in the land that could be the subject of a caveat.
In Leonhardt Estate v MNR, [1990] 1 C.T.C. 2198, 90 D.T.C. 1034 (TCC), the question was whether farm property had rolled over at the father’s cost upon the death of mother, who was the beneficiary of a spousal trust. Father died in 1974 leaving his farm to the trust, with his children to take the farm “upon her death”. Mother died in 1977. The estate did not report a disposition of the farm in 1977. “The estate” sold the farm in 1984. One of the beneficiaries of the estate tried to argue that the gain in 1984 should be computed on the basis that the cost of the farm had been increased by a deemed disposition of the farm on mother’s death. The beneficiary argued that the farm property rollover conditions had not been met in 1977 because, among other things, the executor took no steps to distribute the farm property to the children, which mean that all the beneficiaries acquired on their mother’s passing was a right to require the due administration of the estate. Justice Bonner rejected this argument:
The principles to which counsel referred raise the question whether, on the death of Agnes Leonhardt, the farm was an asset held by the executors in the course of the administration of the estate of Julius Leonhardt. In answer to that question counsel pointed to paragraph 26 of the agreed statement of facts. That paragraph, in my view, falls far short of a clear statement that allocation of the farm to the children did not take place before 1986 because residuary accounts were not prepared before that time. Nothing in the agreed statement of facts suggests that debts of Julius Leonhardt remained to be paid at the time of the death of Agnes Leonhardt or that there was anything else to be done by the executor save to convey legal title to the children. It is of course clear that legal title remained in the executor’s hands at all times prior to the sale of the farm in 1984. On the other hand, the agreement for sale named the executor as vendor but provided for the division of the purchase price among the beneficiaries of the estate of Julius Leonhardt. As I see it the appellants have failed to establish the factual basis for the assertion that the only property which passed on the death of Agnes Leonhardt was a right to require due administration of the estate.
In Hess v R, 2011 TCC 360 (informal procedure), the CRA had imposed penalties on the taxpayer under section 233.6 for late-filing a T1142 in respect of US trust of which he was a beneficiary and from which he derived income. A taxpayer who receives distributions from a non-resident trust need not file the T1142 if the trust is an estate. At trial the CRA argued that the taxpayer was receiving distributions from a testamentary trust and not an estate because the estate had been administered. The court responded as follows (at ¶12):
However, I note that a testamentary trust as defined in subsection 108(1) of the Act means a trust or estate that arose on and as a consequence of the death of an individual. That is to say, an assumption that a trust is a testamentary trust does not preclude such trust from being part of the estate of the Appellant’s deceased great uncle. Further, there is nothing in the assumptions that would direct me to believe that there was an assumption made by the Minister which paralleled the assumption of counsel for the Respondent. The assertion or assumption of counsel for the Respondent was that the estate had been wound up and that the testamentary trust was not an estate but was rather something else. The assumptions in the Reply, however, only state that distributions were first being made to the Appellant’s father and on his father’s death the distributions continued to be paid to him in accordance with the terms of the testamentary trust. There is no assumption that the estate had been wound up or that the testamentary trust was a distinct trust administered separate and apart from the estate by, say, for example, being administered by trustees that were not executors.
Homer v R, 2009 TCC 219, ¶13–17, also discusses the importance of this distinction.
Tax consequences
Before the GRE rules were enacted, the question of whether an estate was still under administration usually didn’t matter much. After the death of a taxpayer, there are three types of taxpayers who might be the recipients of the capital property of an estate and who might be called on to report income arising from that property: the estate under administration, testamentary trusts created by the will of the deceased and beneficiaries of the estate who are entitled to distributions of the estate property. Under the pre-GRE rules, testamentary trusts and estates under administration were all taxed in much the same way because each was entitled to its own set of graduated rates.
Controversy would arise if a person’s will provided for the distribution of property to a beneficiary but the executor of the will delayed the distribution for tax purposes in an attempt to prolong the period during which income would be taxed in the estate at favourable rates. If, for example, the will of a deceased individual provided that all residual property should be distributed to his wife after the administration of his (relatively simple) estate was complete, what would be the result if the executors purported to take two years to complete that administration? The CRA took the position that the administration of an estate was complete if
- its beneficiaries had been identified;
- all its assets had been gathered;
- all its debts or specific bequests had been paid;
- the value of the residue had been ascertained; and
- the final accounts of the estate had been approved.
The CRA took the view that, if the foregoing steps had been completed, but the executor was purporting to continue to file as if the estate were under administration, then the CRA could assess on the basis that the income of the estate should be taxed in the hands of the residual beneficiaries (ie as if the property had been distributed) or as if the trusts created by the will had in fact been settled such that they had commenced to exist for tax purposes.[3]
It seems likely that this position will assume additional importance in the GRE-era because only an estate under administration can be a GRE that will be entitled to its own set of graduated rates (and then only for a period of three years after death). Now the CRA will want to ensure that estate assets are distributed in a timely manner to residual beneficiaries and testamentary trusts.
Some practitioners have suggested that, to allow for the maximum use of the graduated rates of a GRE, wills ought to be amended to provide for a three-year period during which the executors of an estate are entitled to administer it. Query whether this idea will prove helpful given the CRA position set out above. Of course, if the vagaries of estate administration dictate that it will take three years to wind-up an estate, then no one, least of all the CRA, will have any cause to complain. If it takes four years, then so be it—but don’t expect to be able to claim the benefit of graduated rates in Year Four. If, however, the executors have no good reason for prolonging the process beyond the end of Year One, and they continue to file tax returns for the estate as if it were still under administration, they should not be surprised if the CRA issues a reassessment or two to deny the benefit of the graduated rates.
[1] Cf technical interpretation 2014-0553181E5F (June 25, 2015), in which the CRA confirmed that a spousal trust cannot be a GRE.
[2] DWM Waters, M Gillen and L Smith, Waters’ Law of Trusts in Canada, 4th ed (Toronto: Carswell: 2012) at p 49 note 22.
[3] Technical interpretation 9526815.
